4/19/2010 @ 12:00PM

China's New Economy

China’s gross domestic product grew by 11.9 % in the first quarter of this year, according to figures released April 15. The really good news for Beijing is that the economy started the year on a tear.

Even better, inflation remained low during the quarter, up just 2.2%. Strip out food, which is jumping because a once-in-a-century drought has hit the country, and eliminate housing, influenced by skyrocketing property prices, and the Consumer Price Index would have been flat.

Credit Beijing for its impressive mobilization of resources, especially in a difficult period. In the wake of the global downturn in 2008, China’s export-dominated economy faltered. To jump start growth the State Council, the central government’s cabinet, announced a $586 billion stimulus program in November 2008.

Yet the real sources of state spending were Beijing’s cash-swollen banks. Last year these institutions just about doubled lending over 2008 levels on the orders of central government technocrats.

Beijing, directly and through its banks, poured about $1.1 trillion in stimulus into the country in 2009. The results were almost immediate. Exports turned up in December 2009, helping the country overtake Germany to become the world’s top exporter. China also became the world’s largest car market after sales surged 52.9% last year. And although Japan avoided being eclipsed as the planet’s second largest economy in 2009, China will probably overtake its neighbor this year. The rest of us may be mired in recession, but the Chinese are roaring ahead.

Not surprisingly, the unprecedented flow of cash fundamentally altered the structure of China’s $4.6 trillion economy. Historically, exports fueled expansion and accounted for about 38% of gross domestic product and much, if not most, of the growth. Today, about 95% of growth is attributable to state investment.

State investment, unfortunately, is creating a larger state sector and a smaller private one, and it is decreasing the role of consumption, now accounting for 30%–or less–of GDP. Beijing, in effect, substantially changed the sources of growth of the Chinese economy over the course of just one year.

Now the issue for Chinese technocrats is no longer GDP. Even if Q1 growth was 9.9% or 10.9% instead of 11.9%, China is still expanding twice as fast as the country in second place. The issue for Beijing is the consequence of growth. That’s why legendary short-seller Jim Chanos calls China “Dubai times 1,000–or worse.” George Soros on April 9 mouthed the word “bubble.”

And this leads us to the first-quarter CPI number. The National Bureau of Statistics may have gotten out of the business of producing questionable GDP estimates, but it has entered a new line of prevarication. Now that the global narrative is that China is overheating, NBS’s inflation numbers are of great interest around the world.

Beijing’s CPI statistic for March, up 2.4%, was below consensus estimates. And the property numbers from NBS are becoming surreal. In February the bureau announced that housing prices in 70 medium- and large-sized cities increased about 1.5% last year. The increase, we were told, was a five-year low. This was too much for even China Daily, Beijing’s official English-language publication, which reported that people were saying the number “was obviously opposite to the reality.”

Reality in China is that urban property prices last year could have gone up as much as 80% in some cities and by double digits in others. Moreover, they are rising this year, perhaps at the rate of 20% a month in some regions. NBS, however, has continued to understate prices increases. Last week it announced that property prices in 70 major cities last month increased only 11.7% from a year earlier, another apparent fib.

Why is inflation so sensitive to Beijing’s statisticians? Chinese people traditionally take to the streets when prices rise faster than their incomes. It was not a downturn that preceded the Beijing Spring of 1989–and the horrible massacre of June 4. It was the mismanagement of growth, specifically rampant inflation.

China’s technocrats have proven once again they can create gross domestic product. What they have not demonstrated is that they can exit stimulus spending–or that they can handle the growing imbalances and dislocations their spending has created. The economy, unfortunately, is veering from one extreme to the other. Their next act will be to see if they can create a stable economic environment, the necessary condition for sustainable growth.

The concept to watch in the Chinese economy at this moment is velocity. It needs to slow down fast.